Is cash-out refinancing a good idea?

One of the most valuable financial tools you have as a homeowner is your home’s equity. The ability to tap into that value can unlock a lot of doors and help you accomplish your goals. Whether you want to grow your family, pay for your kid’s education, or build your dream kitchen, the value you’ve built up in your home may be the solution.

A cash-out refinance loan is one way you can tap into your home’s equity — but it isn’t the only way. Keep reading to learn when and why a cash-out refinance loan could be the best option for you.

What is a cash-out refinance loan?

A cash-out refinance loan — also known as a cash-out refi — is when you refinance your existing mortgage for more than you owe and take the difference in cash. That cash can then be used as you see fit, such as home renovations or your child’s college tuition. Essentially it’s two financial transactions in one:

1. Cash-out: Borrow against your home’s equity
2. Refinance: Replacing your original mortgage — hopefully at a lower rate

Refinancing your mortgage is a big decision that requires a careful look at your financial picture. Make sure you’re weighing all the pros and cons before making a decision.

How much equity do I have?

To calculate the amount of equity in your home, take your home's appraised value and subtract the amount you owe. The difference is the amount of equity you have. Simple, right?

How much money can I borrow with a cash-out refi?

You probably won’t be able to borrow the full amount of equity in your home. The loan-to-value (LTV) ratio dictates how much a lender is willing to let you borrow. Most lenders use an LTV of 70-80%, which means they won't let you owe more than 80% of the value of your home.

Here’s how the LTV% is calculated:

Current mortgage balance ÷ appraised value of the home = LTV%

For our example: $300,000 ÷ $400,000 = 75%

If your lender’s max LTV is 80%, you can only borrow up to 5% of your equity, or $20,000

Are there fees for a cash-out refinance?

Yes. Closing costs for a cash-out refinance loan are usually about 3-6% of your newly established mortgage. So for a $400,000 property, the estimated closing costs would be $12,000-$24,000. Similar to your original mortgage, the costs normally cover:

• Origination fees
• Underwriting fees
• Appraisal fee (if applicable)
• Title fees

If you want to avoid paying for the closing out of pocket, you may be able to roll the fees into the mortgage. However, this will likely result in higher monthly payments. It’s important to shop around to make sure you’re getting the most competitive loan terms.

When is a cash-out refinance loan a good idea?

Everyone has a unique financial situation, so you’ll need to assess your situation and do the math to determine if a cash-out refi is right for you. Below are some refinance options where a cash-out mortgage could be advantageous:

If you want a lower interest rate: If current mortgage rates are lower or your credit score has improved since you applied for your original mortgage, you may qualify for a better rate. A lower interest rate means a lower monthly mortgage payment — and less interest paid over the life of your mortgage.

If you want a different home loan type: If you have an adjustable-rate mortgage (ARM) and worry that interest rates will rise, refinancing into a fixed-rate mortgage could help. On the other hand, if you already have a fixed rate and want to sell your home soon, refinancing to an ARM could help you save money on interest.

If you want to pay off your loan amount faster: Lenders offer various mortgage lengths from 15 to 30 years. Switching to a shorter term will likely increase your monthly mortgage payment — but it could save you thousands of dollars in interest over the life of the loan.

When should you avoid a cash-out refinance?

Cash-out refinancing can be a great financial tool, but it isn’t the only way to accomplish your goals. Below are some reasons you may want to avoid a cash-out refinance loan:

If you don’t need to borrow the money: If you’ve been looking into mortgage refinancing options and someone is trying to sell you on a cash-out option, think about if you really need the money. If the cash would more of a “nice to have,” consider opening a home equity line of credit (HELOC). The money will be there when you need it, and you’ll only pay interest on what you use.

If you’re not sure how much you need to borrow: If you’re planning on doing a few home improvements over time and you’re not sure how much everything will cost, a cash-out refi may not be in your best interest. As a lump-sum withdrawal, you’ll be required to pay interest on the entire amount of the new loan whether you need it or not. Alternatively, if you don’t have enough for your project, you may have to take out additional funding — which could mean more fees. A HELOC may be a more flexible borrowing option.

If the math doesn’t add up: Before making a decision on tapping into your equity, it would behoove you to do the math and compare all your options. If, over time, a cash-out refinancing would cost more than keeping your current mortgage and adding a HELOC or home equity loan payment, it’s probably not the best financial decision.

Ready to reach your goals?

The convenience of refinancing and tapping into your home equity in one transaction may be worth it for you. But before you make a decision, it’s important to do your homework so that you’re an educated and informed borrower. If you have questions, feel free to give our home lending department a call at 1-888-514-2300, or send us your inquiry here and someone will get back to you within one business day.